Healthcare: Rising Costs or Profits?

Includes: HCP, IHI, JNJ, SNH, XLV
by: Jim Farrish

The health care industry encompasses pharmaceuticals, medical devices, medical equipment, insurers, hospitals and long term care facilities. Each offers its own unique investment opportunities and challenges. Since the new health care reform bill was passed earlier this year, the questions surrounding the impact to both the consumer and businesses remain a constant debate. The complexity of the bill and its true impact has caused many investors to steer clear of the sector.

The latest event to heighten awareness of the challenges facing providers, insurers and companies providing benefits to employees was McDonald’s Corp's (NYSE:MCD) threat to drop coverage on 30,000 plus employees. Robert Gibbs, a White Hose spokesman, confirmed that 30 companies had requested an extension to comply with the new mandates. Specifically, the need to have policies that offered annual coverage limits of at least $750,000 rising to $2 million by the end of 2013. The potential premium increases of 200% were the reason for the threat of dropping the coverage for as many as 1 million employees of these companies.

On the other side of this issue is the insurance companies exiting the business of offering policies. Principle Insurance Company announced they would exit the business all together. The larger providers such as United Health Care and Blue Cross Blue Shield have continued to raise premiums in expectation of the full impact of the new health care bill by 2014.

These issues have heightened the awareness of the two major risks of investing in the health care sector: demographics and regulations. The regulations are at the forefront of the discussion, but the demographics will put more pressure on the sector in coming years as the American population continues to age.

SPDRs Select Health Care ETF (NYSEARCA:XLV) declined nearly 15% after the new bill was passed. Since putting in a recent bottom near $28 in August, the ETF has bounced nearly 10%. Breaking down the sector reveals the potential opportunities in the sub-sectors.

iShares Dow Jones US Pharmaceutical Index ETF (NYSEARCA:IHE) has been in an uptrend since the low in May. The fund has accelerated these past six weeks as companies like Johnson & Johnson (NYSE:JNJ) and Pfizer (NYSE:PFE) have made strong gains. The outlook for the drug stocks remains positive fundamentally, and all eyes will be on the third quarter earnings results.

iShares Dow Jones US Health Care Providers ETF (NYSEARCA:IHF) has been the laggard of the sector. The pressure from the new reform bill has clouded the question on profitability in light of price controls. The sector has bounced more than 12% off the August lows. This is one of the sub-sectors worth putting on your watch list for more upside. The bill is not fully enacted until 2014 and it leaves room for rate increases short term.

iShares Dow Jones US Medical Devices Index ETF (NYSEARCA:IHI) suffered at the hands of the regulatory reform bill more than any other sector. The 2% tax on equipment sold to pay for the new bill hit a sour note on profits and outlook. The bounce off the August low has been positive, but there are still plenty of question marks surrounding profits. Watch to see if the short term uptrend continues.

The sub-sector offering unique opportunities is REITs (Real Estate Investment Trusts). In the health care arena, this gives investors the opportunity to participate in the upside of real estate and demand for better care. The growth and demand for long term care facilities continues to be a challenge across the US. Senior Housing Properties Trust (NYSE:SNH) builds facilities to help fill the void. They currently pay a 6% dividend and have experienced solid upside growth. Occupancy rates have been in excess of 88%, showing that demand remains strong for these facilities. Filtering for these opportunities is worth the time.

There are other opportunities where facilities are owned and operated by REITs. Health Care Reit, Inc. (NYSE:HCP) owns and operates facilities. They currently pay a 5.7% dividend and offer upside growth as well.

Health care as a sector offers many opportunities to investors. There will be more ups and downs as the implementation of the new regulatory reform is phased in, but it is well worth the time and energy to find the parts worthy of investing.

Disclosure: Jim Farrish is the Founder and Editor of and as well as the CEO of Money Strategies, Inc., a Registered Investment Adviser with the SEC. The company and/or its clients may hold positions in the ETFs, mutual funds and/or index funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. Investors who are interested in money management services may visit the Money Strategies, Inc., web site.